The author is a Forbes contributor. The opinions expressed are those of the writer.

Loading ...

Loading ...

This story appears in the {{article.article.magazine.pretty_date}} issue of {{article.article.magazine.pubName}}. Subscribe

Editor's note: Updated on 1/2/2015.

In the countdown to April 15, many people rushing to prepare their individual income tax returns will overlook another key tax document that’s due the same day: Form 709, covering taxable (or potentially taxable) gifts made during the previous year. Others, aware of the need to file, have questions as they prepare this form. I've had a flurry of them lately from readers who read my post, “The Limits On Tax-Free Gifts: What You Need To Know.”

I'm thrilled that they're thinking about how the law applies to their own situation, and will address their concerns and other pitfalls here.

By way of background, if you gave more than $14,000 in cash, property or gifts to anyone in 2014, you must report the gift on Form 709. The rules discussed here apply whether you made the gift to family members or to an unrelated friend – a common source of confusion. Other misunderstandings abound and many Form 709s that should be filed are missed. Mistakes can be expensive, leading to back taxes plus interest, and perhaps penalties if you've tried to dodge Uncle Sam.

The following gift tax questions include some I've recently received from readers, and others that have come up during the 17 years that I've been covering wealth transfer and preservation. Here’s hoping the answers will help you avoid grief from the Internal Revenue Service.

Are gifts you receive taxed?

Gifts from family and friends are not considered income, so there's no income tax. That's true no matter how high the value of gifts you receive in a given year (a reader asked me today about this). But sometimes a gift is subject to gift tax. When it is, the person giving the gift – not the recipient – is responsible for paying the tax.

When must you file a gift tax return?

You can give up to $14,000 worth of assets each year to as many people as you like gift-tax free -- it’s called the annual exclusion. Any gift above this amount counts against your exclusion from gift or estate tax, which was $5.34 million in 2014 and in 2015 has risen to $5.43 million. (Note that the annual gift exclusion remains $14,000 for 2015.)

If you exceed this basic exclusion amount (sometimes called the “unified credit” or the “lifetime gift-tax exemption”) you could wind up owing gift tax of up to 40%. Even if you don’t, your lifetime gifts would reduce how much you can pass tax-free through your estate plan. One reason you must file a gift tax return is so the IRS will know how much of the $5.43million tax-free amount you have used so far.

Must gifts under $14,000 ever be reported?

Yes. To come within the annual exclusion, a gift must be a present interest, meaning that the recipient can use the gift immediately. That’s certainly true with cash, but can be a different story with gifts to trusts, in which beneficiaries don’t have any rights until later. Any time you make a gift that isn’t a present interest, it must be reported, no matter how small the amount.

Are there special rules for married couples?

Yes. The most important one is that the usual limits on lifetime gifts don’t apply. If your spouse is a U.S. citizen, there’s an unlimited marital deduction for most gifts, even if they exceed the annual exclusion amount and you generally are not required to file a return.

A different rubric applies if your spouse is not a U.S. citizen. In that case you must file a gift-tax return if your gifts to him or her total more than $145,000 per year. Additional gifts to a non-citizen spouse count against your $5.43 million basic exclusion and must be reported on the gift-tax return.

Another important tax break is that married couples can combine both their annual exclusions and their lifetime tax-free amounts – it’s called gift-splitting. By using the annual exclusion this way they can jointly give away up to $28,000 to as many people as they want each year without dipping into the $5.43 million lifetime allotment. Ordinarily couples must then file a gift tax return and consent, on each other’s returns, to gift-split.

It’s also possible for spouses to share their $5.43 million basic exclusion amount during life. (Here too, they must file a gift-tax return and consent to gift-split.) But keep in mind that this reduces the amount available to each of them to make tax-free transfers at death to someone other than each other – for example to children. And when the first spouse dies, there will be less unused exclusion left for the survivor to carry over through portability. (For more on portability, click here.)

When married couples use the annual exclusion to gift split, does it matter who signs the checks if the funds are coming out of a joint account?

Adam Toft, a reader, recently sent me this question, which comes up often. Carol A. Harrington, a lawyer with McDermott, Will & Emery in Chicago, recommends couples each write a separate check out of the joint account. "The person who writes the check is considered to be making the gift," she explains. "While married couples can double up, to do that they have to file a gift tax return to make what's called a gift-split election." By writing separate checks they can avoid the need to file a return solely for this purpose.

What if I fund a 529 college savings plan?

A popular use of the annual exclusion is to put money in Section 529 college savings plans, setting up a separate account for each family member you want to benefit. (Note that unlike recipients of gifts that use the annual exclusion and the lifetime exclusion, the beneficiary of a 529 plan must be a family member.)

The law also permits lump-sum deposits of as much as $70,000 per person at once ($140,000 for married couples), but in that case you must file a gift-tax return electing to treat the gift as if it had been spread over five years. During this five-year period, you cannot make additional annual exclusion gifts to the beneficiary of the 529 plan. If you die before the five-year period is up, part of the gift, reflecting the number of years still to go on your five-year gift, will be included as part of your estate.

Is paying tuition for someone a taxable gift?

If you pay a friend or family member’s tuition, dental or medical expenses (including health insurance premiums), it won’t count against either the annual exclusion or your $5.43 million basic exclusion, and you won’t have to file a gift tax return – but only if you make those payments directly to the service provider, such as the school, doctor or insurance company. (See too, “6 Ways To Give Family And Friends Financial Aid.”)

Can a gift tax return be filed late?

Yes. To request an automatic six-month extension to file Form 709, you can file Form 8892. If you are applying for an extension for your personal income taxes, filing the necessary paperwork for that (Form 4868) automatically extends your time to file Form 709, so you don’t need to request the extension separately. Either way, though, if you owe tax, you must pay it by April 15 (use the voucher on the Form 8892 for this) or you will owe interest and perhaps penalties.

If you didn’t file gift tax returns for past tax years, it’s not too late to correct the situation. Generally speaking you have until the IRS catches the problem. When you’re not liable for gift tax, there’s no penalty for late filing.

Still, this poses an interesting dilemma for people who make relatively modest gifts without realizing that they have exceeded the annual exclusion. For example, after I spoke recently about women taking charge of their finances, someone in the audience told me that in 2012 she had helped her daughter with home repairs to the tune of about $20,000. At the time the annual exclusion was $13,000. Mom is a widow and the daughter is single. Should Mom file a gift tax return reporting the petty amount of $7,000 ($20,000 minus $13,000)?

Had Mom been aware of the limitations, she might have chosen to lend her daughter the difference, instead of giving her the whole thing. Such intrafamily loans are a great way to keep money in the family. But you must charge a minimum rate of interest set each month by the Treasury, called the applicable federal rate, to avoid potential gift tax and income tax consequences. The latest IRS rates can be found online here. (For more on arranging a loan to family members, see my post, “5 Ways To Help Family Pay For Housing.”)

However, since Mom had already given daughter the money, she can't now go back and re-characterize the transaction, says Harrington. She should file a gift tax return reporting the 2012 gift. In 2012 the lifetime exemption amount was $5 million; unless Mom has made subsequent gifts that use up the exclusion (which is $5.43 million in 2015) she won't owe any gift tax.

Martin Personick, a reader who is going it alone, asks: “My wife and I split cash gifts in 2013 of about $100,000 to our son and daughter. Am I right to assume that much of the form is not pertinent to us? I filled out information on the donor and donees and the amounts. Also I referred to similar cash gifts made in 2010.”

If all your gifts were in cash (as opposed to hard to value assets) you assume correctly that much of the form is not applicable, says Harrington. But you still need to file it to make the gift-split election. It's also necessary to file a separate return for any past years in which your gifts exceeded the annual exclusion, if you haven't already, she adds. You can't just disclose those gifts on the 2013 return.

Should you file a return even if you’re not required to?

This question is not as ridiculous as it sounds. You might want to file a return if there’s room for debate about what your gift is worth. Under the tax law and IRS regulations, to start the statute of limitations running on your gift tax return, you must make “adequate disclosure” of the gift. The only way to do that is to file a gift tax return reporting the gift.

Are gift tax returns audited?

Yes, and filing one (even just to start the statute of limitations running) means you might get audited. However, when you make a transfer that’s clearly a taxable gift, the law requires you to report it. Plus, after you die, during an estate tax audit, the IRS can question – and tax – gifts you made many years earlier if you didn’t file a return reporting them.

Is it ever too late to make a gift-split election?

Yes, Harrington says. If you have already received a deficiency notice from the IRS, you can no longer make the election. Barring that, it's not uncommon to file a gift tax return and make the election long after the gift has been made or even after someone has died.

For example, Harrington says she once opened the estate of a client who had been dead for five years in order to file the return making the gift-split election. In this case, two brothers who were co-owners of a company had each made parallel gifts to their own children.

After one of the brothers died the other brother, who was still alive, was audited. Concerned that the dead brother's heirs might receive a deficiency notice, Harrington saw to it that his surviving spouse filed a gift tax return electing to split the gifts from years earlier. By gift-splitting the brother who had died would owe no gift tax.

How long should gift tax returns be kept?

Since the $5.43 million lifetime exclusion from gift tax and any gift tax you pay are cumulative, you must keep the returns indefinitely. Your heirs need them to calculate the tax, if any, on your estate. And the most likely time for the IRS to flag unreported gifts or to question the value of the gifts you made is after you die. You do everyone a favor by leaving all the documentation behind.